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Last month I argued that indiscriminate “banker bashing” ignores the fact that banking is a large, complex industry and that while some parts (for example, much of investment banking) have been revealed in recent years to be clearly dysfunctional and deserving of criticism, other parts (for example most of retail transaction processing) have performed quite well. In particular, I argued that the systems meltdown at RBS, a failure of basic banking and payments “plumbing” which was widely portrayed as yet more evidence that “banks are evil”, was actually a fairly isolated incident caused mainly by bad luck, with an element of incompetence it’s true, but no suggestion of moral turpitude. Indeed, it is my opinion that the global payments industry, especially in the UK, is a shining example of one part of banking which has consistently delivered reliability, integrity and value for money throughout the current banking malaise. As a postscript it is therefore disappointing that the government has now decided to dismantle the excellent Payments Council – a classic case of fixing what isn’t broken.

The Libor scandal at Barclays, on the other hand, is a much more serious and shocking development where vigorous banker bashing is quite clearly justified. As everyone is now aware, the Libor-fixing at Barclays occurred in two phases. As early as 2005 it now transpires that Barclays derivatives traders actively persuaded those responsible for Barclays Libor submissions to manipulate rates in Barclays’ favour. Then at the height of the banking crisis in 2008 it appears that Barclays submitted artificially low rates to give a false impression of the bank’s financial health. Worse still, it may well emerge that many or most of the biggest banks in the world were involved in such activities, possibly even with the tacit approval of regulators. Just to give a feel for the sheer scale of this scandal, Libor is used to set the rates used in a range of financial transactions worth an estimated £800 trillion per year, or twelve times global GDP. Clearly this is a case of widespread, criminal dishonesty and moral bankruptcy, not just at individual banks but endemic within the global banking system as a whole.

So what went wrong and what can be done to put it right? It will be many years before we have definitive answers to these questions, but I for one now believe the rot set in during the 1980s with the gradual merging of investment banking and commercial banking activities which had previously been strictly separated, at least in the US, under the Glass-Steagall Act. I have to admit that in those heady days culminating in London’s “Big Bang” of 1986, I was one of those who fully embraced the wave of deregulation which led to two decades of explosive financial innovation and growth and established London as arguably the world’s pre-eminent financial centre. But with hindsight it now seems probable there were important systemic flaws at the heart of this new industry model and we are all now paying the price. The giant organisations which now dominate global banking are not only too big to fail but also apparently too complex to manage, let alone regulate. Senior managers with a commercial banking background lack the understanding of investment banking to be able to manage the complexities and risk inherent in that side of the business. Senior managers with an investment banking background, conversely, bring the questionable morals and culture of “casino banking” to bear on the commercial banking side of the business, either mis-selling financial products to consumers to boost profits, or using vast pools of capital underwritten by us, the taxpayers, to make irresponsibly risky transactions. And what about those “Chinese Walls” which were supposed to separate investment banking from commercial banking? Looking at some of the emails which have emerged in the Barclays case, the idea now seems laughable.

The key lesson to be learned from this sorry story is, I believe, that what we are witnessing is a systems failure, which will require a systems solution. More on this next month, but in the meantime, bring back Glass-Steagall – all is forgiven!

Banking Automation Bulletin Article, September 2012, by Nick Collin

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